Identifying macro-trends and disruptive factors
Robert GORDON – Stanley G. Harris Professor in the Social Sciences, Northwestern University – Bloomberg’s Fifty Most Influential Thinkers 2016
Raghuram RAJAN – Professor of Finance at Chicago Booth, Former Governor of the Reserve Bank of India, Former Chief Economist and Director of Research at the IMF
Dr. Jürgen STARK – Former Member of the Executive Board and the Governing Council of the European Central Bank
Philippe ITHURBIDE – Global Head of Research, Chief Economist at Amundi
Moderated by Adrian DEARNEL – Founding Partner, EuroBusiness Media
The economic environment is changing: The Fed is tightening monetary policy, the end of negative interest rates and quantitative easing is in sight, and world trade is in trouble. How will developed and emerging countries deal with this, and where will the next crisis come from?
SECULAR STAGNATION OR GROWTH IN DEVELOPED COUNTRIES?
Opening the roundtable, Robert Gordon differentiated developed and emerging countries. The per capita GDP of emerging countries such as China is still less than 20% of that of the US. However, it will continue to grow rapidly, while developed countries such as the US, where productivity growth has slowed to 0.5%, will experience consistently slower growth. The situation in Japan, the four Asian tigers, and Europe is similar. Many productivity gains from technology have already been achieved, as have gains from major demographic shifts such as urbanization.
Jürgen Stark and other panellists proved more optimistic, at least for Europe. He pointed out that reforms, coupled with ECB support, have restarted growth in Europe. Recent elections may be proof that there is sufficient political will to carry out further reforms in the labour market, as well as in service sectors and banking, which still suffers the legacy of the financial crisis. He was also confident that future inventions will lead to renewed productivity growth. Philippe Ithurbide shared this cautious optimism, hoping that secular (long term, non-cyclical) stagnation can be avoided. It helps that some European countries can now use both monetary and fiscal measures, and can cooperate more constructively due to the centrist election results.
Raghuram Rajan also hailed recent growth and explained that secular stagnation and productivity growth are badly understood. Productivity may not be well measured in certain sectors, such as services, or may be masked by cyclical factors. And other sectors, particularly health care, still have potential for dramatic productivity gains. However, he was concerned about tightening labour markets, especially in the US, which could lead to wage growth, inflation, and ultimately tighter monetary policy.
This was echoed by Mr. Gordon, although he did not feel that this would lead the Fed to drastically tighten rates. Turning back to business cycles versus secular stagnation, he stated that the conditions underlying present growth, such as low interest rates and low energy prices, will not suddenly disappear. However, other factors, such as overvalued stocks, particularly of technology firms, are a warning sign.
« In the United States slowing productivity growth is only half the problem. We also have slowing growth in hours of work. You put the two together– output per hour and hours of work–and our GDP growth has slowed from 3% to a little more than 1%. »
A GENTLE END TO QUANTITIVE EASING?
Panellists feared that quantitative easing (QE) will have to end at some point, and that it must be handled with care. Mr. Ithurbide pointed out that Japan is stuck with QE and that the US must find a way to taper it down gently. Mr. Stark asked, “at a certain point in time, the business cycle will come to an end. What kind of ammunition do central banks have available, if they are not willing to end or taper quantitative easing or raise rates?”
He felt that monetary policy has been too accommodating and that now there are risks of financial sustainability. However, it is difficult for the ECB to exit; it must start with tapering and at a later stage consider raising rates. Above all, this must be communicated very carefully to avoid market volatility. Mr. Rajan went further, questioning the value of QE, and whether its effects on long term interest rates have been rewarded with investment. Referring to recent remarks by ECB President Draghi, he posited that QE maybe only serve as a signal for the timing of monetary policy tightening.
« Tight labour markets imply higher wages, which imply higher inflation, which implies tighter monetary policy. It could be that we are not that far away from that. »
WHEN WILL INTEREST RATES RISE?
Agreeing with others that the Fed is behind the curve to keep interest rates low while the business cycle is peaking, Mr. Ithurbide expected it to tighten again before the end of the year, and then to gradually start reducing its balance sheet. A misinterpretation of the intentions and decisions of the Fed has long been a major risk factor, he emphasized. This is all the more true since, in half of the cases since 1945 (six out of the last 12), monetary tightening cycles were followed by a US economic recession within two years. The fear is that the Fed moves too quickly and, especially, too strongly. For the moment, however, the Fed remains cautious. It must avoid all communications errors. Markets could react poorly if rates are increased prematurely, excessively, without sound rationale, or by surprise. “The stronger the fiscal and tax stimulus, the more the Fed will be able to raise its key rates without causing too much damage on the financial markets”, Mr. Ithurbide asserted. The ECB, on the other hand, will not tighten before 2019 and will continue tapering.
Turning to QE, Mr. Rajan wondered whether it had sufficiently strengthened markets, such as US mortgages or European government bonds, to allow a gentle exit. “We have to re-examine whether the adjustment in prices is taking place, because governments are behaving better and doing all the things that are necessary to bring yields under control; or whether, in fact, the central banks are key to the process.”
Mr. Stark added that the main effect of the €2 trillion in bonds issued by the ECB was on government bond yields, with highly-rated Germany and France gaining 20 to 30 basis points, and Spain and Italy about 60 to 90 basis points. When QE started, interest rates were already low, and the deleveraging process and balance sheet repair, particularly in banking, was not well enough advanced. Therefore, the credit channel was blocked, and QE had only moderate benefits. But this was an issue for national governments, not the ECB.
Philippe Ithurbide agreed, but recalled that QE was highly beneficial for peripheral countries, and undoubtedly contributed to the decline in spreads, and to the elimination of major risks such as the financing of deficits. Who is scared about the debt sustainability of Spain and Portugal, he asked, when every year the ECB buys much more than the amount of net issues? So QE has had real short-term advantages for peripheral countries, as well as its long-term effects.
Mr. Gordon cautioned that holders of US long-term bonds may face large losses if markets assume the Fed will not raise the federal funds rate and begin to wind down its portfolio, raising bond yields to over 3%. “I would think that the order of magnitude of increase in the government bond rate might be the straw that breaks the back of the US stock market. That may bring implicit yields on the stock market back down to earth.” The drop could be around 10% in the next two years, he specified.
« Quantitative easing and negative interest rates are based on the wrong diagnosis: the diagnosis of deflationary risk.In my view, this risk was never real. »
WHERE WILL THE NEXT CRISIS COME FROM?
Responding to a final question from the moderator on where future risks may come from, Mr. Rajan pointed to China, where a tightening in the financial sector could lead to slower growth later this year He worried how China can fix second-tier banks, reign in the shadow financial system, and deal with high company debts in a slower growth environment.
For Mr. Stark, the debt issue goes beyond China, with global debt levels the highest since the Second World War. Inflation is not the way we should deal with public debt, he cautioned. A second issue is the disruption of globalisation and world trade. After the crisis in 2008, G20 heads committed to fighting protectionism, but since then hundreds of restrictive trade measures have been imposed.
Philippe Ithurbide added that, “everybody is waiting or fearing a financial crisis. Maybe the next one will come from economic and political problems, such as populism, de-globalisation, protectionism, or insularity in some countries. In that sense, the world is different from the one we had to face twenty years ago.” However, the immediate problem for the financial system is over-valuation, he emphasized. One of the challenges of emerging countries such as China, India and Russia, is to generate enough domestic demand to promote growth while the global economy slows down. They must avoid stagnant growth and wages, and improve living conditions. Greater international cooperation is essential for this.
Given the last word, Robert Gordon agreed, repeating his prediction of a stock market correction in the next two years.
« QE is short-term gain with long-term pain. When Europe wanted to implement it, we had difficulty; and now, when we would like to exit, we have difficulty again. »